Purchase - $10.00

Toward a Bottom-Up Approach to Assessing Sovereign Default Risk

14 Pages Posted: 21 Mar 2011  

Edward I. Altman

New York University (NYU) - Salomon Center; New York University (NYU) - Department of Finance

Herbert A. Rijken

Vrije Universiteit Amsterdam (Free University)

Date Written: March 18, 2011

Abstract

The authors propose a new approach to assessing sovereign risk that focuses on the underlying profitability and financial condition of a nations private corporate sector. More specifically, the authors show how their new Z-Metrics approach an updated and expanded version of the Alt-man Z-score methodology can be used to measure the (cumulative) median probability of default of the non-financial sector for the next five years, both as an absolute measure of corporate vulnerability and a relative measure that can be compared to the risk of other sovereigns and to the market's assessment as reflected in the prices of credit default swaps. In testing their approach, the authors measure the default probabilities of listed corporate entities in nine European countries, as well as the U.S., at two different points in time: the start of 2009 (and thus prior to the recognition of the Euro crisis by markets and most credit professionals) and for the first four months in 2010 (essentially, the beginning of the recognition of the crisis). Based on these two observations, the authors suggest that their corporate health index of the private sector would not only have served as an effective early warning indicator, but provided a (mostly) useful hierarchy of relative sovereign risks. In addition to predicting sovereign default risk, another potentially valuable use of the authors' model is to remind policy makers of the importance of a profitable private sector to the financial health of sovereign governments.

Suggested Citation

Altman, Edward I. and Rijken, Herbert A., Toward a Bottom-Up Approach to Assessing Sovereign Default Risk (March 18, 2011). Journal of Applied Corporate Finance, Vol. 23, Issue 1, pp. 20-31, 2011. Available at SSRN: https://ssrn.com/abstract=1790187 or http://dx.doi.org/10.1111/j.1745-6622.2011.00311.x

Edward I. Altman (Contact Author)

New York University (NYU) - Salomon Center ( email )

44 West 4th Street
New York, NY 10012
United States
212-998-0709 (Phone)
212-995-4220 (Fax)

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Herbert A. Rijken

Vrije Universiteit Amsterdam (Free University) ( email )

De Boelelaan 1105
Amsterdam, 1081HV
Netherlands
+31 20 5986101/6060 (Phone)
+31 20 5986020 (Fax)

Paper statistics

Downloads
4
Abstract Views
564